If none of the exclusions discussed above applies, you must determine whether a worker is an employee or IC under your state’s workers’ compensation law. If the worker qualifies as an employee, you must provide workers’ compensation coverage. (Remember: Even if you know what a worker’s classification is under the IRS rules and under your state’s unemployment laws, you must still check your state’s workers’ compensation rules, because a worker may be an IC under some rules but an employee under others.) Each state has its own workers’ compensation law with its own definition of who is an employee. However, these state laws follow one of three patterns.
- Most states classify workers for workers’ compensation purposes using the common law right of control test.
- Other states use a relative nature of the work test, either alone or in conjunction with the common law test.
- A few states use different classification schemes.
Find your state in the chart below and read the applicable discussion. For more detailed information on your state’s workers’ compensation laws, contact the state workers’ compensation agency.
When reading about your state’s law, keep in mind that most state workers’ compensation agencies and state courts interpret their workers’ compensation laws to require coverage. This is because the workers’ compensation laws are designed to help injured workers, and it’s considered beneficial for society as a whole to have as many workers as possible covered. Generally, if there is any uncertainty as to how a worker should be classified for workers’ compensation purposes, state workers’ compensation agencies and courts find that the worker is an employee who should be covered.
1. Common Law States
A majority of state workers’ compensation statutes define an employee as one who works for, and under the control of, another person for hire. The right to control the details of the work is the primary test used to determine whether an employment relationship exists. (See Chapter 3 for a detailed discussion of the common law test.)
The list of factors used to measure control varies somewhat from state to state. But the goal of the test is the same: to determine whether the hiring firm has the right to direct and control the worker in the way he or she works, both as to the final results, and as to the details of when, where and how the work is to be done.
The following states use a four-factor test to determine if a hiring firm has the right of control: Alabama, Idaho, Kansas, Mississippi, Montana, New Jersey, North Dakota, Oregon, South Carolina and West Virginia. These states ask whether
there is direct evidence that the hiring firm has the right to control the performance of the work itself, including how, when and where it is performed
- the hiring firm has the right to discharge the worker and the worker has the right to quit at any time
- the worker is paid by the job or on a time basis—hourly, weekly, monthly, and
- the hiring firm supplies the worker with valuable equipment.
- In Chapter 3, we discuss all of these factors in detail.
It is far harder to prove that a person is an IC than an employee for workers’ compensation purposes. Because the states want as many workers as possible to qualify as employees, it is not necessary for all four factors to indicate that there is an employment relationship for a worker to be deemed an employee for workers’ compensation purposes. Rather, one or two factors are usually sufficient. For example, a worker’s compensation auditor who discovers that you have the right to fire a worker at any time for any reason, or for no reason at all, will likely stop the audit right there are conclude that the worker is your employee. But even workers who cannot be discharged without cause may be employees.
EXAMPLE: Joanna, a driver who delivers dry cleaning for Ace Cleaners, designates her own delivery schedules and routes and is otherwise not controlled by Ace. She has a one-year contract with Ace that provides that she cannot be terminated or quit unless there is a material breach of the contract.
However, Ace provides her with a delivery truck and pays her by the hour. These two factors alone are enough to show an employment relationship for workers’ compensation purposes. The combination of a hiring firm providing a driver with a vehicle and paying by the hour is almost always enough to show employment for workers’ compensation purposes.
To establish IC status, you will usually have to satisfy all the factors discussed above, with the possible exception of the method of payment.
EXAMPLE: An Oregon country club hired Marcum, an unemployed logger, to prune dead wood from some trees on the golf course. He was injured after a few days on the job and filed a workers’ compensation claim alleging that he was the club’s employee. The court concluded that Marcum was an IC. The court examined all four factors and found that three indicated IC status, the fourth was neutral.
- Control: There was no direct evidence of control over Marcum by the club. A club member testified that he simply told Marcum what trees to prune. He did not tell him how to do the work or what hours to work. Marcum hired an assistant and paid him himself. Marcum had no continuing relationship with the club—he had never worked for it before.
- Right to fire: The club member who hired Marcum stated that he felt he could terminate Marcum’s contract only if he was not properly doing the job.
- Equipment: Marcum furnished all his own equipment, including saws and a pickup truck.
- Method of payment: Marcum was paid $25 per tree. Such piecework payment indicated neither IC nor employee status.
2. Relative Nature of the Work Test
Despite the fact that most states now use the common law test discussed above, there is a growing trend to use a test that makes it more difficult to establish that a worker is an IC: the relative nature of the work test. This test is based on the simple notion that the cost of industrial accidents should be borne by consumers as a part of the cost of a product or service. If a worker’s services are a regular part of the cost of producing your product or service, and the worker is not conducting an independent business, this test dictates that you should provide workers’ compensation insurance for the worker.
On the other hand, you don’t need to provide workers’ compensation if a worker is running an independent business and the worker’s services are not a normal everyday part of your business operations—the cost of which you regularly pass along to your customers or clients.
To determine whether a worker is an employee or IC under the relative nature of the work test, ask two questions:
- Is the worker running an independent business?
- Are the workers’ services a regular part of the cost of your product or service?
If the answer to both questions is yes, the worker is an employee for workers’ compensation purposes.
Many states use the relative nature of the work test in conjunction with the common law control test. If a worker’s status is unclear under the common law test, these states use the second test. Other states use only the relative nature of the work test. Check the chart, above, to find out what your state does.
a. Independent business
If a worker is running an independent business and has the resources to provide his or her own insurance coverage for work-related accidents, it’s reasonable not to require the worker’s clients or customers (meaning you) to provide such coverage.
It’s much easier for highly skilled and well paid workers to qualify as ICs under the test than low-skill low-pay workers. Highly skilled workers are most likely to have their own independent businesses and to earn enough to be financially responsible for their own accidents.
Workers’ compensation agencies and courts might also examine many of the factors from the common law test. (See Federal Taxes and the IRS Rules for a complete discussion of the IRS common law test.) A worker is more likely to be viewed as operating an independent business if he or she:
- makes his or her services available to the public—for example, by advertising
- does not work full time for you
- has multiple clients and income sources, and
- has the right to reject jobs you offer.
b. Part of the cost of your product or service
A worker’s services will likely be viewed as a regular part of the cost of your product or service if:
- the worker’s services are a regular part of your company’s daily business operations
- the work is continuous rather than intermittent, and
- the duration of the work indicates continuous services as opposed to contracting for a particular job.
c. Examples
EXAMPLE 1: Ceradsky was killed while operating a milk truck owned by Purcell. Purcell had contracted with a cheese manufacturer to pick up milk from farmers along a specific route and deliver it to the cheese factory. Although Purcell and Ceradsky had been classified as ICs by the cheese company, Ceradsky’s survivors applied for workers’ compensation benefits from the company. The court held that they were entitled to benefits because both Ceradsky and Purcell were employees of the cheese company under the relative nature of the work test.
The milk hauling was not an independent business, but only an aid to the cheese company’s production process. Purcell and Ceradsky hauled milk exclusively for the cheese company six days a week for years. They did not earn enough money from the work to be expected to purchase their own insurance. In addition, the milk hauling work was a regular and essential part of the company’s cheese production process, the costs of which were passed on to cheese consumers.
EXAMPLE 2: Ostrem suffered an eye injury while installing a diesel engine in a piece of heavy equipment owned by a construction company. He applied for workers’ compensation benefits from the company and was denied them because he was an IC under the relative nature of the work test. First, the court found that he operated an independent business: he was highly skilled, established his own rate of pay and hours, took out a business license, was generally unsupervised, had multiple clients and made his services available to the public. Second, Ostrem’s work was not part of the construction company’s regular business. He had been hired to install one engine only and had never worked for the company before. The job should have taken only a few days. He had been hired to complete a single job, not to do regular work of the construction company.
3. Other Tests
A few states have somewhat different tests for determining who qualifies as an employee for workers’ compensation purposes. The tests used in Michigan, Minnesota, Oregon, Washington and Wisconsin define who is an employee much more clearly than the common law or relative nature of the work tests. If you’re doing business in one of these states, consider yourself fortunate. California is another story, however.
a. California
California uses at least two tests—the common law test and a second economic reality test. If a worker is an IC under the common law test, the California Workers’ Compensation Appeal Board and courts will use the second broader economic reality test to try to find employee status for the workers involved.
Under the California version of the common law control test, a worker is more likely to be viewed as an IC if he or she:
- has the right to control the manner and performance of his or her own work
- has a monetary investment in the work
- controls when the work begins and ends
- supplies tools and instruments needed for the work
- has a license to perform the work
- is paid by the project rather than by unit of time (such as hourly payment)
- is engaged in a distinct occupation or business
- is highly skilled
- can’t quit at any time
- was hired for a temporary and fixed, rather than indefinite, time, and
- believes, along with the hiring firm, that the relationship is an IC relationship.
California uses the same economic reality test that applies to federal labor laws. This test emphasizes whether the worker functions as an independent business or is economically dependent upon the hiring firm. Under this test, a worker is more likely to be viewed as an IC if:
- the worker has the right to control the manner and performance of his or her own work
- the worker’s opportunity for profit or loss depends on his or her managerial skill
- the worker supplies his or her own tools and instruments
- the services rendered require a special skill
- the working relationship is temporary rather than permanent, and
- the services rendered are not an integral part of the hiring firm’s business.
b. Michigan
Michigan uses an economic reality test to determine a worker’s status for both workers’ compensation and unemployment compensation purposes. (See State UC Classification Tests, Section B4, for more information on this test.)
c. Minnesota
Minnesota uses the four-factor common law test described above, but has designed special rules for 34 specific occupations that are intended to serve as a safe harbor—that is, workers who come within the rules are deemed ICs. These occupations include: artisans, barbers, bookkeepers and accountants, bulk oil plant operators, collectors, consultants, domestic workers, babysitters, industrial home workers, laborers, orchestra musicians, several types of salespeople or manufacturer’s representatives, agent drivers, photographers, models, some professional workers, medical doctors providing part-time services to industrial firms, real estate and securities salespeople, registered and practical nurses, unlicensed nurses, taxicab drivers, timber fellers, buckers, skidders and processors, sawmill operators, truck owner-drivers, waste materials haulers, messengers and couriers, variety entertainers, sports officials, jockeys and trainers. (See Minn. R. § 5224 and following.)
d. Oregon
Oregon uses an eight-factor statutory test to determine a worker’s status for both workers’ compensation and unemployment compensation purposes. However, one Oregon court has used the four-factor common law test discussed in Section 1, above.
e. Washington
In Washington, a worker is an IC for workers’ compensation purposes if all the following six conditions are met:
- the worker is free from control while performing the services
- the worker’s services are either:
- outside the hiring firm’s usual course of business, or
- performed outside the firm’s places of business, or
- performed at a workplace for which the worker pays
- the worker is engaged in an independent business, or has a principal place of business that is eligible for a federal income tax business deduction
- the worker is responsible for filing a Schedule C or similar form with the IRS listing the worker’s business expenses
- the worker pays all applicable state business taxes, obtains any necessary state registrations and opens an account with the State Department of Revenue, and
- the worker maintains a separate set of articles or records showing all income and expenses of the worker’s business.
f. Wisconsin
Under Wisconsin’s test, a worker is an IC for workers’ compensation purposes if the worker satisfies nine conditions. He or she must:
- maintain a separate business with his or her own office, equipment, materials and other facilities
- hold or have applied for a federal employer identification number
- operate or contract to perform specific services or work for specific amounts of money, with the worker controlling the means of performing the services or work
- incur the main expenses related to the service or work that he or she performs under contract
- be responsible for completing the work or services and be liable for failing to complete it
- receive compensation for work or services performed under a contract on a commission, per job or competitive bid basis and not on any other basis—for example, hourly payment
- be able to realize a profit or suffer a loss under the contracts
- have continuing or recurring business liabilities or obligations, and
- have a business set-up in which success or failure depends on the relationship of business receipts to expenditures.
4. Consequences of Misclassifying Workers
You will suffer harsh penalties if you misclassify an employee as an IC for workers’ compensation purposes and have no workers’ compensation insurance.
Most state workers’ compensation agencies maintain a special fund to pay benefits to injured employees whose employers failed to insure them. You will be required to reimburse this fund or pay penalties to replenish it.
In addition, in most states, the injured worker can sue you in court for personal injuries. Most states try to make it as easy as possible for injured employees to win such lawsuits by not allowing you to raise legal defenses you might otherwise have, such as that the injury was caused by the employee’s own carelessness.
You will also have to pay fines imposed by your state workers’ compensation agency for your failure to insure. These fines vary widely, ranging from $250 to $5,000 per employee or may be based on the amount of workers’ compensation premiums that should have been paid. The workers’ compensation agency may also obtain an injunction—a legal order—preventing you from doing business in the state until you obtain workers’ compensation insurance.
If you are doing business as a sole proprietor or partnership, you will be personally liable for these damages and fines. And the fact that your business may be a corporation won’t necessarily shield you from personal liability. In some states, shareholders of an uninsured corporation may be personally liable for the injuries sustained by the corporation’s employees. For example, in California, any shareholder of an illegally uninsured corporation who holds 15% or more of the corporate stock, or at least a 15% interest in the corporation, may be held personally liable for the resulting damages and fines.
Finally, in almost all states, failure to provide employees with workers’ compensation insurance is a crime—a misdemeanor or even a felony. An uninsured employer may face criminal prosecution, fines and, in rare cases, prison.